From the California Policy Seminar Brief Series, June 1998

FOREIGN TRADE AND CALIFORNIA'S ECONOMIC GROWTH

Cynthia A. Kroll, Dwight M. Jaffee, Ashok Deo Bardhan, Josh Kirschenbaum, and David K. Howe

Foreign trade is playing an increasingly large role in the U.S. economy, and an even larger role in California's economy. Our research examines in detail the effects of expanding foreign trade on the level and composition of output (all goods and services) and employment in California. As state government has many trade-related programs directed toward improving California's economy, we also examine the implications for state policy of the rise in international trade.

Our research is based on the understanding that globalization is a complex process. Accordingly, the set of studies that we summarize here address several interrelated sets of questions:

• Is global trade a significant factor in the growth of California's economy? How does trade affect the level of employment and output? Does trade shift employment and output among industrial sectors?

• How do local firms adjust to compete in global markets? Do trade flows affect firms' location decisions? Does expanding trade change a firm's production process?

• Does trade affect the occupational distribution within industries? What is the role of trade in occupational segmentation among firm locations? Do trade flows affect the distribution of wages and employment between blue-collar and white-collar workers? Does foreign trade contribute to growing inequality in relative wages and in the demand for different types of labor?

• To what countries do California firms, as a whole, export, and why to these countries? How influential are a Pacific Rim location and an immigrant population in determining the level and direction of trade?

• Is state-government assistance desirable either to encourage trade or to deal with the impacts of trade? What are the options for policy makers?

THE AGGREGATE EFFECT OF FOREIGN TRADE ON CALIFORNIA'S ECONOMY

Global trade is of growing significance in California's economy. We estimate that for California, exports as a share of all goods and services produced in the state increased from 8% in 1987 to over 15% in 1995. In addition, trade through California's ports has risen dramatically: California accounted for 12% of total shipments through U.S. ports in 1980, but 21% by 1995.

High-tech sectors, including computers, electronics, instruments, and aircraft, account for more than 70% of merchandise exported by California producers. Agricultural products, including food products and crops, are the next largest export sector (about 9% of merchandise exports). Foreign trade is also important to some of the state's major services sectors, including motion picture production, tourism, and--directly and indirectly--software (e.g., computer programs and data processing). No data are reported on imports at the state level, but U.S. data indicate that import competition is significant to a wide range of California industries, including computer hardware, electronic equipment, textiles and apparel, and travel.

The growth of exports in California in the past decade has been closely tied with the economic expansion of Pacific Rim countries. Asian countries, Canada, and Mexico are California's primary customers, together accounting for over two-thirds of state exports. Trade agreements, such as NAFTA and the General Agreement on Tariffs and Trade (GATT), have expanded both export opportunities for California firms and opportunities for import competition. Proposals for the Asia-Pacific Economic Cooperation Forum (APEC) could further increase trade, in both directions, with Pacific Rim countries.

In our analysis we took into account the effects of both exports and imports on California's economy, extrapolating from U.S. data when detailed information was not available for the state. Conceptually, one might expect that rising exports would help California, while rising imports would hurt the state's economy. In fact, we found a much more complex situation, affecting both manufacturing and services sectors.

On the export side, trade appears to increase output and employment for California manufacturing sectors, approximately in proportion to the share of sales accounted for by exports. On the import side, our quantitative analysis did not discover a one-to-one corresponding loss in output and jobs as imports rise as a share of domestic sales. We suggest two related explanations for this. One is the growing role of imports as inputs (ranging from raw materials to production equipment) to production in California, allowing the importing producers to expand their operations. The second is the overall growth in demand for specific goods (for example, computers) as foreign competition lowers prices overall and drives up efficiency in production, yielding an expanded market for both U.S. and foreign producers.

We also found it important to look beyond direct effects (such as jobs added to increase export activities) to indirect effects (such as the purchase of U.S.-made software by domestic users of imported computers). The computer sector is an excellent example of ways in which trade may affect services sectors both directly and indirectly. The computer-services sector has a positive trade balance and benefits directly from increased foreign sales. Foreign trade, however, is a relatively small part of computer-services revenues; indirect effects of foreign trade may produce much greater revenues for this sector. For example, the expansion of the computer hardware industry (in which trade plays a large role) has greatly increased the demand for software, such as operating systems, custom installations, and packaged programs. We estimate that at a minimum, expansion in software demand due to trade has produced enough jobs to counterbalance all of the computer manufacturing jobs lost in California between 1987 and 1995 (about 28,000) and may have expanded jobs in software by close to 80,000 during this period.

IMPACTS AT THE INDUSTRY LEVEL

While the rise in aggregate trade for California is positive, the summary picture masks transitions that occur as a result of trade. Some individual industrial sectors clearly experience job displacements as a result of trade, while other sectors see substantial shifts in the mix of their labor force. We examined two industries in detail, the computer cluster and food processing, to further understand the role of trade in economic growth in California. Our analysis drew on a number of data sources and on detailed interviews at the firm level.

California manufacturing industries can be divided into high-trade-flow and low-trade-flow sectors, depending on whether trade accounts for a large share of U.S. shipments (all products sold by U.S. companies, domestically or abroad) and domestic sales (including imports). Industries can be further divided into those with trade surpluses (exports exceed imports) and those with trade deficits (imports exceed exports). On the manufacturing end, the computer cluster represents a high-trade-flow sector with a current trade deficit, while food processing is a low-trade-flow sector with an overall trade surplus.

Both case-study industries encompass more than manufacturing activity. The computer cluster also includes computer-services activities, and food processing is closely linked to California agriculture.

Computer Cluster

For the computer sector, we found that global linkages are integral to the rate and characteristics of growth, as well as geographic location of production. Both overseas sales and imported inputs are important to this sector's growth. Although many of the computer firms are quite young, they have quickly spread production beyond California's borders. Most of the larger firms reported that their sales abroad made up between one-third and two-thirds of their total sales, with many of the products manufactured in the global market area where they are sold (e.g., Asia, Europe, North and South America). Imports play a significant role in production. Computer hardware firms estimated that 10-20% of their inputs were directly imported (as opposed to purchased from U.S. distributors, from whatever geographic source). In addition, transshipments occur within companies, with components manufactured overseas used as inputs to products assembled in California.

A firm's location characteristics vary by subsector and market position. Software firms in general had fewer production sites abroad and used fewer imported inputs compared to hardware firms. However, larger software firms were more likely to resemble computer hardware firms in production strategies, using low-cost Asian sites for duplicating disks or spreading production to several sites close to Asian and European markets. Among hardware firms, those with few competitors and customized products were less likely to have overseas production facilities. The youngest firms were also more likely to locate only in California.

Global production also influences the characteristics of a firm's California labor force. Professional, technical, and administrative staff were most likely to remain within the state, while overseas sites had primarily production and/or sales workers.

Food-Processing Industry

In contrast to the computer cluster, global linkages are much less significant in shaping California food processing. Many of the firms in this sector had been in business for 50 years or longer, and few had overseas production facilities. (Indeed, some were once multinational firms that had sold off their out-of-state operations.) In general, sales of processed foods were growing much more slowly than sales in the computer cluster.

With the exceptions of almond and citrus producers, most food-processing firms exported 10% or less of their output. Many of the food-processing firms had "niches" as high-quality producers, based on the quality and reliability of California produce. They faced relatively little competition from producers in other nations, either in domestic or overseas markets (although some firms noted that a few overseas producers are beginning to compete in the high-end market).

Because it does not face the intense global competition found in the computer cluster, the food-processing industry is much less geographically segmented than computer manufacturing. Relatively few California food-processing firms have ventured into global markets as producers. Where they have established overseas plants, the primary motive appears to have been to process specialized products grown abroad rather than to achieve cost savings. Because California food-processing companies maintain most of their production in state, the California workforce in this industry is divided primarily between administrative and production workers, unlike the computer cluster.

These case studies demonstrate that foreign trade may have a much stronger effect on some industries than on others (depending on the importance of trade flows to the industry). For high-trade-flow sectors, trade expansion may affect both the location of production and the mix of the labor force. Trade expansion will have less of an impact on low-trade-flow industries, at least directly and in the short term.

SHIFTS IN BLUE- AND WHITE-COLLAR EMPLOYMENT AND WAGES

The case studies suggest that high-trade-flow industries whose industrial base is in California will often succeed in the global marketplace by adjusting their production process to better compete against foreign producers. Adjustments may include moving portions of production abroad and making greater use of imported inputs at home. Changes of this type are often done to reduce costs, and are likely to have implications for the occupational mix and wages of workers remaining in California. Within the computer cluster, this adjustment is apparent in the high shares of professional and technical workers in their California labor force as compared to the firms' occupational distribution worldwide.

The computer cluster is an industry that has the opportunity to be quite "footloose," and therefore may not be typical of all manufacturing industries. To more broadly understand the role of globalization in the structural change of California's manufacturing industries, we looked at one indicator of structural change, the production-worker (blue-collar) shares of wages and employment, and how they change with measures of globalization.

For manufacturing as a whole, the wage gap between blue-collar and white-collar workers has been growing, and the payroll share going to blue-collar workers has been dropping for at least a decade. Building on econometric techniques of other researchers, we estimated the role played by imported inputs in these trends. Our statistical analysis, across over 200 manufacturing sectors, shows that the increase in imported inputs accounts for 20-25% of the loss in payroll share by blue-collar workers. Industries with pre-existing low shares of blue-collar workers were particularly vulnerable to further loss of blue-collar work, while those with high initial shares were more likely to see an increase in payroll share for blue-collar workers.

EXPORTS, PACIFIC RIM LOCATION, AND IMMIGRANT NETWORKS

Both California's location and its population base contribute to the level and geographic pattern of its foreign trade. While data are not available on imports into California markets specifically, we have analyzed exports from California producers to identify the factors underlying the state's existing trade patterns. We found that market size (gross domestic product, or GDP) is the primary determinant of California's level of exports to another country. Geographic location is another influential factor. Asian markets account for over half of California exports, compared to about 30% at the national level. Japan is California's largest single export market. Canada and Mexico are also significant export markets for the state, together accounting for about 18% of exports.

Markets and location are not the only explanatory factors, as determined by statistical analysis performed for this study. A foreign market's wealth (GDP per capita) and openness (exports and imports as a share of GDP) are also important determinants of the amount of a country's trade with California. The number of immigrants from a particular country who have settled in California is another significant factor in determining the level of exports to that country. Indeed, immigrant networks could significantly counteract the negative effects of distance in determining the level of exports from California to other countries.

Even after foreign-market characteristics, distance, and immigrant networks were taken into account, we found that California industries favor Asian nations as export destinations. One possible explanation for the high percentage of exports to Asia is the relationship between California companies and Asian producers: California firms may trade components and semifinished products back and forth with Asian firms as part of their production process.

FOREIGN TRADE AND CALIFORNIA ECONOMIC-DEVELOPMENT POLICY

Our research demonstrates the complex effects of global trade on California's economy. Foreign trade clearly affects California's economy, not only through the opportunity to export to overseas markets, but through a myriad of other mechanisms, including import competition, imported inputs, foreign direct investment by California firms, and the investment by foreign firms in economic activities in California. None of these forms of expanding global trade has a simple, unidirectional positive or negative impact. Some of the cross-flows are summarized in the table. Exports, while adding jobs and revenue to California, may also lead firms eventually to shift a portion of production abroad. Production abroad, on the other hand, may allow an industry to grow at a pace that would have been impossible under the domestic cost structure, and may also stimulate expansion of California-based support industries. Imported goods compete with California products (sometimes) but provide lower-cost items for consumption by California customers and lower-cost inputs for California producers.

Thus state policy makers, in responding to the impacts and opportunities of trade, will do so in an environment where the two are closely intertwined. Furthermore, from the firm's point of view, export and import factors are only one set of elements affecting their growth. Firms may view state programs established to address concerns over exports or imports as one part of a larger package of economic-development resources (or possibly barriers) provided by the state.

Potential Positive And Negative Effects For Californiaof Expanding Global Interactions

Type of Global Interaction / Positive Effects / Negative Effects
Exports / Adds jobs, revenues to state businesses. / As firms widen export markets, may move production abroad.
Foreign Direct Investment by California Firms. / Adds revenues to state businesses, may add high-wage jobs, support other California firms. / May move blue-collar and even technical jobs out of California.
Import Competition / In the long term, may lead to worldwide expansion of markets. / May reduce revenue and employment for California firms.
Imported Inputs / Lower costs for California firms. / An imported input for one firm may be competition for a domestic supplier.
Foreign Investment in California / May add jobs and increase supplier business. / May be another way for foreign firms to compete in U.S. markets.

Note: The positive and negative effects suggested in this table are broad generalizations. The reality is more complex.